CIR V ALBANY FOOD WAREHOUSE LTD HC WN CIV-2008-485-1444

CIR V ALBANY FOOD WAREHOUSE LTD HC WN CIV-2008-485-1444 26 May 2009IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY CIV-2008-485-1444UNDER section 26A of the Taxation Review Authorities Act 1994 IN THE MATTER OF an appeal from a decision of Judge P F Barber (Decision No. 7/2008, TRA No. 010/07) sitting as the Taxation Review Authority BETWEEN COMMISSIONER OF INLAND REVENUE Appellant AND ALBANY FOOD WAREHOUSE LIMITED Respondent Hearing: 6 April 2009 Appearances: H W Ebersohn and C Bryant for the appellant R A Green and I Thain for the respondent Judgment: 26 May 2009JUDGMENT OF CLIFFORD J Introduction[1] On the morning of 6 June 2001, the directors of Albany Food Warehouse Limited, the respondent, declared a fully imputed dividend. [2] The dividend so declared was resolved by the directors to be credited to the relevant shareholders' current accounts, with payment from those accounts conditional on the shareholders agreeing to subordinate their claims to therespondent's creditors generally and only to be made "as and when finance permits". The shareholders agreed to those terms that day. [3] Later that afternoon, share transfers were executed representing a change in shareholding which breached shareholder continuity for the purposes of the respondent's imputation credit account. [4] The Commissioner decided that in these circumstances the dividend was not "paid" prior to shareholder continuity being breached. The Commissioner therefore determined there had – by reason of the loss of shareholder continuity – been a debit to the respondent's imputation credit account prior to the payment of the dividend, so that the dividend was not received by the respondent's shareholders imputed with any pre 6 June credits. [5] The respondent appealed that ruling to the Taxation Review Authority. The Authority ruled that the dividend had been paid prior to the breach in shareholder continuity, allowing those imputation credits to be used as originally intended. The Commissioner now appeals that decision.Background[6] In very general terms the imputation credit account regime provided by sub- part E of the Income Tax Act 1994 (the Act) (as applied at the relevant time) seeks to avoid double taxation between a company and its shareholders. When a company pays tax it records the payments as credits in its imputation credit account. When it pays a dividend, it can attach those imputation credits to the dividend. Whilst individual shareholders must then return the dividend as income, they can use the imputation credits to satisfy their income tax liability. [7] More specifically, under s ME5(1)(a) of the Act a company's imputation credit account is debited in respect of imputation credits attached to a dividend "paid by the company during the imputation year". Pursuant to s ME5(1)(i) imputation credits in a company's imputation credit account are automatically debited from that account, and accordingly cease to be available, when there is a change inshareholding, which means that there is a loss of continuity amongst at least 66% of what are known as the "voting interests in the company", from the date upon which the credit arose. [8] In this case, therefore, if the dividend declared on the morning of 6 June 2001 by the respondent was not paid prior to the afternoon of 6 June 2001, when that shareholder continuity was breached by reason of the share transfers executed, then the imputation credits recorded in the respondent's account would have been lost before that dividend was paid, and therefore could not be attached to it. [9] There is little, if any, dispute as to the facts. [10] In May 2001, it was proposed that two of the three shareholders in one of the two shareholders of the respondent be changed by the placement of those shareholders' shares into a family trust. A witness for the respondent stated in the hearing before the Authority:9. I was concerned to ensure that any change in shareholding did not have the consequence that [the respondent's] imputation credits would be lost because of a loss of shareholder continuity. This was an important issue from the point of view of both shareholders. It was therefore necessary to declare and pay a dividend prior to the proposed change of shareholding and the loss of continuity. It was also desirable that the dividend be declared prior to the next provisional tax payment date on 7 June 2001 as that payment would increase the credits in the imputation credit account which would need to be distributed.[11] Directors' and shareholders' resolutions were signed on the morning of 6 June to effect the declaration and payment of the dividend. Those resolutions provide as follows: a) Directors' resolution:That a dividend of $[X] fully imputed be declared. Such dividend is to be credited to appropriate Dividend accounts. An amount equivalent to the total tax paid retained earnings for the year ended 25 February 2001 can then be transferred to shareholder loan accounts. The payment of the amount in the shareholder current accounts is conditional on the shareholders passing a resolution to the effect that such payment will be subordinated to payment of all liabilities incurred by the company in the normal course of business and will only be effected as and when finance permits.b) Shareholders' resolution:That receipt by shareholders of the dividend approved by directors on 6 June 2001 will be subordinated to the payment of all liabilities incurred by the company in the normal course of business and will only be paid as and when finance permits.[12] The amounts standing to the credit of the shareholders' current accounts as a result of the declaration of the dividends were not paid to the shareholders on 6 June. They were, however, paid in full by a number of instalments through the balance of the month of June. [13] Additional evidence before the Authority for the respondent, and accepted by the Commissioner, was that no entries were made to so-called "dividend accounts". Rather the amounts in question were simply debited to retained earnings and credited directly to the shareholders' current accounts. The evidence was that the reference to a "dividend account" in the directors' resolution was an error because there was no such account. Transfers were made directly to the current accounts. That happened once the shareholders' resolutions were signed. [14] Journal entries, reflecting that crediting, were actually made in September 2001. [15] Under s OB1 of the 1994 Act, the word "paid" in the context of dividends is defined as including any amount distributed, credited, or dealt with in the interests or on behalf of a person. [16] Before the Authority, the Commissioner maintained that the dividend declared on 6 June had not been paid to the shareholders prior to the loss of continuity because at that point no funds had been placed unreservedly at the disposal of the shareholders. The Commissioner relied on a number of cases that deal with the question of when payment is made, including in the context of determining whether a taxpayer has thereby become liable to be assessed for income tax.The Authority's decision[17] As Mr Green for the respondent modestly acknowledged, the Authority in his decision effectively adopted the submissions that Mr Green had made. [18] The essence of the Authority's decision is, in my view, found in the following passage:[39] It seems to me that the shareholders' current accounts were credited with the amount of the dividend by virtue of the resolutions which were passed at a time before there was a loss of shareholder continuity. In passing those resolutions, the shareholders and directors of the disputant were fully aware of why the dividend had to be unconditionally paid at that time and, if that was not the case, of the consequences for the imputation credit account of the disputant. [40] For the purposes of the relevant statutory provisions, ss ME5 and ME6 of the Act, the word "paid" is defined in s OB1 of the Act as including "distributed, credited, or dealt with in the interest or on behalf of " a shareholder. Although the word "credited" is not defined in the Act, I accept that its ordinary dictionary meaning includes to enter a sum on the credit side of an account. There can be no dispute that a current account is equivalent to a banking account. The crediting of the shareholders' current accounts in the present case resulted in an advance to the disputant by its shareholders on the terms agreed. The amount of the dividend was "credited" to the shareholders within the meaning of the statutory definition of the word "paid" when the directors' and shareholders' resolutions were passed. The amount of the dividend was also "paid" to the shareholders within the ordinary meaning of that term.[19] In reaching those conclusions, the Authority accepted the respondent's argument that a distinction was to be drawn between the directors' decision to declare and credit a dividend to the shareholders' current accounts, and the directors' decision, and the shareholders' agreement, as to the basis upon which the credit balances so created were payable to the shareholders. [20] The Authority concluded that the crediting of a dividend to a current account meant the dividend had been paid within the ordinary meaning of that term. Moreover, the extended definition of "paid" in s OB1 was specific authority, in the context of the imputation credit regime found in Part ME, for that conclusion.Discussion[21] Under s OB1 of the Act, the word "paid" is given an extended definition for a variety of purposes, including Part ME:(g) In the imputation rules, Parts HG, ME, and MF, and sections CZ4, GC24, KH2, MD3, and NH7, and OB6, includes distributed, credited, or dealt with in the interest of or on behalf of [22] In determining for the purposes of s ME5(2)(a) whether the dividend was paid on 6 June 2001, it is therefore necessary to show that it was paid – within the general, undefined, meaning of that word "paid", or as included within that defined term by the words "distributed, credited, or dealt with in the interest of or on behalf of " the shareholders of the respondent. [23] As reflected in the Authority's decision, before the Authority Mr Green had argued that the dividend had been paid both in the ordinary sense of the word and in terms of the extended definition. Before me, Mr Green relied more on his argument as to the appropriate interpretation of the extended definition. [24] I will therefore consider the Commissioner's appeal first on the basis of what I consider to be the correct interpretation of the extended definition of "paid" found in s OB1, and in particular the word "credited". I will then consider the principal alternative arguments that were made. [25] The directors of the respondent resolved on 6 June that the dividend declared was first to be credited to "appropriate Dividend accounts" and then transferred to shareholder loan accounts. As matters transpired, there were no such Dividend accounts. The amounts were debited to retained earnings and credited to the shareholders' current accounts. [26] The term "credited" is not defined in the Act. The word "credit" is defined in the Shorter Oxford English Dictionary as:10. n. The acknowledgement of payment by entry in an account; (a sum entered on) the credit side of an account; "5. v.t. Enter a sum on the credit side of (an account) or of the account (of a person), (foll. by with the sum); enter (a sum) on the credit side of an account (foll. by to the account, the person whose account is credited).[27] I have little difficulty in concluding that the directors' resolution provided for the "crediting" of the dividend to the shareholders' current accounts within the meaning of the word "credited" as it appears in s OB1 in para (g) of the extended definition of "paid". [28] In my judgment, and as a matter of general company law, the effect of the directors' resolution, albeit together with the shareholders' resolution agreeing to the subordination terms, was that funds that were previously available to the directors, in their discretion to apply for the purposes of the respondent's business generally, were placed outside the directors' control and became debts due and owing to the shareholders and able to be sued for as such if not paid on their terms, and proved for in liquidation. This substantive change is reflected in the accounting treatment, whereby amounts that had previously stood to the credit of the shareholders' funds of the respondent, were re-categorised by the dividend resolution and became credits in the shareholders' current accounts. As the respondent in my view correctly submitted, the declaration and subsequent crediting of the dividend amount to the shareholders' current accounts therefore constitute a "crediting". [29] Before me, Mr Ebersohn for the Commissioner refined the Commissioner's position. I understood him to acknowledge that, were it not for the subordination arrangements, the Commissioner would accept that the dividend had been paid. I have decided not to resolve the case simply on the basis of that acknowledgement. Were I to have done so, the only question would be the significance of the subordination arrangement. [30] On that point, I do not think that the agreement by the shareholders, that the debt so created would be owed to them by the respondent on a subordinated basis, meant that a crediting had not occurred. Put very simply, an amount of money to which the shareholders only had a residual claim became an amount to which they were entitled as creditors of the company. That amount had been "credited" to theircurrent accounts, and therefore in my view "paid" in terms of the extended definition found in s OB1. [31] I note further, although this matter was not expressly referred in the submissions I received, that my understanding is that there was, as regards at least one of the shareholders, a debit balance in their current account at the time of the declaration and crediting of the dividend. I understood the Commissioner to accept that, to the extent that the crediting of the current account extinguished that debit balance, the dividend had been "paid". In my view, this confirms that an effective payment by crediting had taken place. [32] I think the conclusion I have reached is consistent with the general scheme and purpose of the dividend imputation regime. That is, by crediting the amount of the dividend to the shareholders' accounts at a specific point in time, the entitlement of those shareholders, now as creditors of the company in respect of the declared dividend, was established. The debt thereby acknowledged was correspondingly an asset for those shareholders. It is consistent with the overall imputation regime that those shareholders who had been shareholders during a period when continuity was maintained and the underlying tax paid should have the benefit of the imputation credits with respect to the tax-paid income represented by that dividend. [33] Indeed, although Mr Ebersohn for the Commissioner expressed general unease with the subordination arrangement, he was not able to point in this instance to there being any "mischief" involved in the arrangement effected by the taxpayer, nor to the outcome of those arrangements as sought only by the taxpayer being anything other than were appropriate in terms of the imputation regime. [34] Moreover, and in general terms, it would seem that income equivalent to the dividend is derived by the shareholders at that time, thus making it appropriate that imputation credits may effectively be attached so as to meet the liability for income tax on that income in the manner intended by the imputation system. Mr Ebersohn endeavoured to persuade me that it was not appropriate to place too much emphasis on the relationship between the derivation rules and the operation of the imputation rules in deciding this appeal. With respect, I found that argument difficult to follow.It was Mr Green's submission that there was a symmetry to be found, and appropriately so, between the two approaches. That is, a dividend paid in terms of paragraph (g) in s OB1 would also be considered to have been derived in terms of s EB1 of the Act. Although, perhaps, there may be individual taxpayers whose particular situations require a different approach, it is difficult to see that being the case often. [35] In my view, these more general considerations persuasively support the conclusion I have reached. [36] The Commissioner's argument, on the extended definition of "paid", was that the extended definition did not fundamentally change the concept of payment and that, further, the concept of "crediting" meant that funds referred to:funds that are made available/put at the disposal of the payee or applied for the benefit of the payee. Something must actually have been given.[37] First, and as has recently been established by the Court of Appeal in Begg & Ors v Commissioner of Inland Revenue [2009] NZCA 160 "means and includes" definitions, and therefore in my view also "includes" definitions, extend the meaning of the principal term being defined beyond that which it would normally cover. Therefore, and even were the Commissioner right to argue, as he did, that the term "payment" generally meant there would only be a payment where money was placed unreservedly at the disposal of a shareholder, that would not preclude a "crediting" that came within the extended definition of the term "paid" from constituting payment here. [38] Secondly, in making that argument as to the general meaning of the term "payment", the Commissioner relied on the English decision of Garforth (Inspector of Taxes) v Newsmith Stainless Limited [1979] 1 WLR 409. [39] With respect, Garforth is not authority for that proposition. In Garforth, Walton J was called upon to decide whether bonuses that had been credited to directors' accounts in a company's books constituted "payments" for the purposes of s 204(1) of the Income and Corporation Taxes Act 1970. In deciding that thosecredits did in the circumstances of that case constitute such a payment, Walton J was at pains to avoid making any general proposition as to what the term "payment" might mean. He commented:I said a moment or so ago that the question was as to the meaning of the word "payment", but I think that probably that is putting the matter too high. The real question is whether the circumstances disclosed in this case, which are circumstances of a commonly recurring nature, fall within that word. It is not I think necessary, or perhaps even possible, to give an exhaustive definition of the word "payment" (at 410).[40] Walton J further commented:Now there can be no doubt at all, I think – and if authority for this is wanted it is to be found in the judgment of Jenkins LJ in In re Vestey's Settlement[1950] 2 All ER 891, 901 – that the word "payment" is a word which has no one settled meaning but which takes its colour very much from the context in which it is found.[41] Therefore, and as Walton J concluded:Whatever may be the strict meaning of the word "payment" – whatever, indeed, may be the strict meaning of the word "payment" in s 240(1) [sic] – I am clearly of the opinion that the placing of the money unreservedly at the disposal of the directors as part of their current accounts with the company was equivalent, in the present case, to payment (at 416).[42] On that basis, it is a little difficult to see how Garforth can be any more than authority for that rather specific proposition. It is certainly not, in my view, and as claimed by the Commissioner, authority for the general proposition that the concept of payment requires "moneys to be placed unreservedly at the disposal of the person to whom payment is made". [43] What the Commissioner relied on, in this his core argument, was an obiter comment from Walton J which contrasted the position where moneys have, as in the case he was considering, been placed unreservedly at the disposal of the directors and a case which might involve some lesser entitlement:After all, if the taxpayer company were to put money into the account with a note on it saying that it is to be paid out only as and when the board of directors decide, or as and when the taxpayer company in general meeting passes a resolution to that effect, or some qualification of that nature, then the money would not be unreservedly at the disposal of the director, he couldnot do with it what he liked, and we would be a long way away from payment (at 415).[44] When seen in the broader context of Garforth, I do not think that proposition can be sustained so as to overcome – by reference to some fundamental concept of payment – the interpretation of the extended definition of the term "paid" set out above. As Walton J himself noted, the concept of payment has no settled meaning and takes its colour very much from the context in which it is found. Garforthsimply does not establish the general proposition the Commissioner suggested. [45] On the Commissioner's argument that crediting required something to actually have been given, then in my view something clearly has been given here. That is, the shareholder is now the holder of the chose in action represented by the entry in his current account, and able to deal with that chose in action in any of the manners permitted by law. [46] On the basis of that analysis, this appeal against the Authority's decision can be dismissed without, in my view, the need for extensive reference to the various other authorities relied on by the Commissioner. Nevertheless, I make the following comments in relation to what I took to be the principal other cases that were so relied on. [47] In The Commissioners of Inland Revenue v Doncaster (1924) 40 TLR 433 the High Court of Justice considered a situation involving a resolution authorising directors to distribute a "Dividend Equalisation Fund" – money set aside out of profits as a reserve fund to be at the complete disposal of the directors for the time being – as "a funded debt payable at the option of the directors in cash or in fully paid preference shares at par". The directors then resolved to pay the Fund in cash and credit the amount to which each shareholder/director was entitled to his loan account with the company. Rowlatt J held that the Fund was paid, and was therefore receivable by the directors as income, on the passing of the resolutions, and that the respondent director's share of the Fund was properly included in computing his total income for Super-tax purposes for the year in question. Prior to the passing of the resolutions, the monies in the Fund were not paid because they were at the "absolutecontrol of the Directors" (my emphasis) and were therefore not at the shareholders'disposal. Here, of course, the amounts credited to the shareholders' current accounts were not at the directors' absolute control – they were debts due and owing to the shareholders subject only to the subordination agreement. Rowlatt J held that credits in the shareholder's loan account "were money in the hands of the Company belonging to the shareholder" (at 631). [48] Alliance Group Limited & Anor v Commissioner of Inland Revenue (1995) 17 NZTC 12,066 was also relied on by the Commissioner. In that case, the issue was whether a redundancy payment, paid in two instalments in 1991 and 1992, came within the Income Tax Act 1976 definition of a "lump sum" payment. Doogue J found for the taxpayers. An alternative argument of the taxpayers was that there was a lump sum payment because in 1991 the full amount had been credited to each employee's individual account in the company's financial records. At the date of each distribution, the amount of the distribution was debited to those individual accounts and direct credited to the employee's bank accounts. Doogue J held that the initial crediting "did not result in a crediting to the accounts of individual employees of sums upon which they could draw" and therefore did not amount to a payment. It was simply an acknowledgement of liability. Doogue J noted, at 12,072, that "[w]hilst crediting can undoubtedly result in payment on the facts here that was not the case". Here the shareholders could draw on the sums subject only to the subordination agreement. [49] A further case relied on by the Commissioner was Blott v Commissioners of Inland Revenue [1920] 2 KB 657. However, as stated by Walton J in Garforth (at 77), and quoted by the Authority in this case (at 14,063):At first blush one has [the Judge appealed from in Blott] saying that there is no payment of a dividend unless the company parts with it ... But, of course, if I may say so, this is a totally wrong use of authority. It is of no use extracting from any case a mere sentence or two without putting those sentences in their context; and the context in Blott's case was that profits were being capitalised, were being turned into additional shares, were being used to pay up the shares in full, so that at the end of the day what the shareholder received was shares and not money". ... I do not think [Blott] is of any assistance at all, because it was directed to an entirely different point and entirely different circumstances.[50] I similarly adopt this summation. [51] I would also adopt the Authority's comments in relation to two further cases relied on by the Commissioner:[56] Brookton Co-operative Society Limited v FC of T 81 ATC 4346; (1981) 11 ATR 880, a decision of the High Court of Australia, also supports the stance of the [respondent]. Mason J in his judgment said, at p 889: "Payment of a dividend may occur in a variety of ways not involving payment in cash or by bill of exchange, as, for example, by an agreed set-off, account stated or an agreement which acknowledges that the amount of the dividend is to be lent by the shareholder to the company and it is to be repaid to the shareholder in accordance with the terms of that agreement. It is, however, well settled that the making of a mere entry in the books of a company without the assent of the shareholder does not establish a payment to the shareholder. Manzi v Smith (1985) 49 ALJR 376 at 377; 7 ALR 685 at 687-688." [emphasis the Authority's] [57] In the present case there is not a mere entry in the books of the [respondent] without the assent of the shareholders. The credit to the current account was clearly made with the assent of the shareholders and that assent was given together with an agreement, which was contained in a shareholders' resolution, that the repayment of the loan to the disputant, which was created and acknowledged by the act of crediting, would be made as finance permitted and that the loan would be subordinated to certain other liabilities of the company. [58] The Commissioner claims support for his view, that the dividend was not paid, from the decision of Henry J in IRC v Taylor (1964) 9 AITR 374. I agree with Mr Green that Taylor was a completely different case. The issue was whether Mr Taylor had derived dividend income on 25 March 1954 or in a later financial year when the dividend would be taxable. First, the directors did not have power under the articles of association to declare an interim dividend. They only had power to pay an interim dividend — which could be rescinded before payment. Second, it was clear from the terms of the resolutions, as was found by Henry J, that no dividend was declared until the directors exercised their discretion in the future having regard to available cash. Third, as a result of the initial resolution, amounts were credited to special accounts called dividend accounts and were only credited to the shareholders' current accounts as and when the directors (or shareholders) did exercise their discretion in a series of subsequent resolutions over subsequent years. [59] As it was found that the directors did not have the power to declare a dividend, that effectively determined the case. Nevertheless, Henry J proceeded to consider what the position would have been on the assumption that the declaration of the dividend was valid. The important point is that Henry J found that a dividend did come into existence when amounts were debited to the newly created dividend accounts and were credited to the shareholders' current accounts.[52] In my judgment, therefore, these cases do not assist the Commissioner.[53] There is, however, one point on which I differ from the Authority. In reaching his decision, the Authority concluded – as Mr Green had argued before him, but not so strongly before me – that the crediting of the dividend amount to the shareholders' current account effectively involved the making of a loan by the shareholders to the company, and therefore a prior payment of the amount so loaned from the company to the shareholders. In these circumstances, I do not find it easy to categorise the amounts standing to the credit of the shareholders' accounts as representing "loans" made by those shareholders, and therefore to necessarily involve there having been a prior payment of the amount so lent. Rather, the better interpretation is that the amounts so credited, whilst they remain as debts due from the company to its shareholders, involve those shareholders providing financial accommodation to the company. That does not, however, alter the conclusion I have reached. [54] There is one final matter I need to comment on. [55] As noted at [14] physical entries to the respondent's books of account were not made until some time in September. The Authority's decision records that the Commissioner accepted that the crediting of the current accounts was effective on 6 June. Moreover, and correctly in my view, the Authority relied on Case K60 [1988] 10 NZTC 487 where Judge Bathgate said at 495:The book entries and the accounting entries made subsequently are no more than evidence of what had been done by the resolution. The company and its directors had to disclose the making of the dividend and how it was effected. That was done subsequently by the entries into the financial books and accounts of the company. However, those entries merely recorded what had already transpired.[56] On that basis, I do not think there is anything in the fact that physical entries were made subsequently. [57] Before me Mr Ebersohn did endeavour to make a contrary submission, and in doing so suggested that the Commissioner had not agreed to the position recorded in the Authority's decision. Mr Green strenuously objected to that suggestion.[58] On the basis of the material before me I am unable to accept Mr Ebersohn's suggestion. Furthermore, I think the position articulated as a matter of law by Judge Bathgate and relied on by the Authority is the appropriate approach to take. I therefore do not think this matter assists the Commissioner. [59] For all these reasons, the Commissioner's appeal is dismissed. [60] I see no reason why costs should not follow the event, on a 2B basis. If that matter cannot be resolved, the parties are to file written submissions to me. Submissions for the taxpayer should be received within 21 days of this judgment, and for the Commissioner within seven days thereafter. In neither case should those submissions exceed three pages."Clifford J"Solicitors: Crown Law Office, P O Box 2858, Wellington 6140 for the appellant (harry.ebersohn@crownlaw.govt.nz) DLA Phillips Fox, P O Box 160, Auckland 1140 for the respondent (Counsel: richard.green@counsel.co.nz)